All men’s miseries derive from not being able to sit in a quiet room alone. – Blaise Pascal

Posted by: donmihaihai | March 16, 2008

China stocks not looking pretty?

That is the title of a commentary written on this weekend BT and the reason is Prime Partners China Index, the Index for China companies listing in SGX, melted 56% since Oct 1, 2007. A drop of 56% is painful, no wonders this lady journalist come out with such a title but only if one is speculator. For investor with patient that can sit on his ass for a long period, this present opportunities. Opportunity to buy companies at cheap price, especially those China companies that listed in SGX. And this is not the 1st time it happen, back in 2004/2005 when the CAO saga happened, almost every China stock(from a smaller pool) was throw away except some themes play. If I remember correctly, one can easily buy a basket of 10 to 20 stocks trading at 4 to 6 X earnings. Not many investors take the bite because well, no one wanted to trust these companies with China management. They are perceived as 2nd or even 3rd class and I don’t remember reading commentaries saying that it was a good time to buy China stocks except be cautious. Time change and China stock come back in favour since the start of 2006 until late 2007 and these stocks especially newly IPOed can easily traded at valuation of 15 to 30 X earnings or even more with almost everyone buying the China story and forget what happen 1 to 2 years back. Together with the current decline of the market, China stock seen to be hit especially hard. I can easily find China stock trading at single digit valuation with some going back to 4 to 6 X earnings again. The swings in mood with perception is fast or say volatile but that present opportunity for investor to buy stock at a cheap again. So if this senior lady jurist is writing for long term investor, the title of should be change to “China stocks look like a beauty” but is she?

It is usually when the near term outlook suck which is why stock are selling at a low valuation, Third Avenue Funds owner Martin Whitman keep saying this and it is perhaps true right now, with price inflation that eating into the margins of many China companies, add in the global uncertainty at the moment, the outlook seen to be…. suck. But like the changing mood of investor, the mood of the economy will be changing from suck to good and to suck again. Unless one can sell at the peak, shake legs, buy at the bottom, shake legs then sell at the peak…. well keep doing it for cycle and cycle. If not we can always buy when everything look suck, hold on until thing look good again.

Recently there is a book review on Investing the Templeton Way (by Lauren Templeton/Scott Phillips) publish 2008 . It writes

Sir John Templeton along with Shelby Davis and others was one of the first foreign investors to see the enormous potential in Japan in the 1950s & 1960s. Japan was a country characterized by high GDP growth. It was developing from simply being a low-cost producer of textiles into producing higher value added industrial goods. Japan ’s people were savers and worked hard. Finally, the government was slowly loosening the rules on foreign ownership and opening up the economy.

And

Japan was ignored by most investors who still saw it as a producer of cheap and inferior goods and a country that lacked the economic might of the United States . As a result stocks were very cheap. Templeton rode the Japan stock market juggernaut over the period of 1959 into the 1980s. From 1959 to 1989 the Japanese index raised 36x from its original value (see graph p 93 “Investing the Templeton Way ”).

Let not forget that during 1959 to 1980s, the world was hit by high commodities bubbles and stagflation in the 1970s. While Japanese stock end up in a secular bear market after 1989, an index that rose 36X in 30 years is super impressive and it always begin with a market where valuation is low. The China stocks are not super cheap if we look at Shanghai Index or even those listed in Hong Kong(perhaps there are many smaller listed companies trading at low single valuation which I don’t know) but those listed in Singapore are different because here is not the 1st choice of many China companies, especially those bigger in size which also lead to many foreign investors give Singapore listed China stock or S-share a miss due to size and lack of investors interests, those that are buying are usually from retail investors. As a result, periods of low valuation can be common irregardless of the quality of these companies. I do not know whether it is good to buy every single China stock that trade at 4 to 6 X earnings but low valuation provide a good margin of safety which also mean huge losses can be avoided.

Let take a look at a list of China stocks which either I owned or in my watchlist for whatever reasons and what is their valuation using PE, PB and ROE.

Just by looking at the above list, I can easily find 5 stocks trading at PE of 4 to 6 X earnings. The rest of the stocks are not that expensive as well. This list is neither being specially picked just because they are trading at low valuation nor for show. They are specially picked because I have their numbers readily which mean no more digging is required for this write-up. The actual number of China stock is about 6X my list which also mean there can be as many as 20 to 40 China stocks trading at 4 to 6 X earnings. From the look of it, it seen that there is a possibility that 70% of all China stocks listed here are trading at single digit earnings. Wow, not bad, lot of stones to be turn. What more, most of them are not loss making and some are even having good profitability. No wonder I can keep adding on to my current holdings without buying into new stock at this moment.

The current situation can last a few months to a few years but let’s not forget a famous quote from Ben Graham, “The market is there to serve you, not to guide you.”

Its time to do more digging but with my speed, I won’t be able to increase my list significantly before the situation change. I can bet on that.

Hey dmhh, i am glad you still remember me. Thx for sharing your blog as it is really enjoyable reading it.

Life is mediocre for me. so far my stocks are just barely profitable. But i am getting more excited as the STI drops….

There are many reasons to having a manufacturing arm. But it just does not make sense to me the manufacturing margin will be higher than what they are doing right now. Afterall, their margin has already been dropping steadily over the years.

Ya, i absolutely agree with you that the receivables are of concern. Days sales outstandings are increasing drastically, especially over last two years…have problem collecting their money back…?

Why not? Remember Pru global basic turnover ratio? It is down to a more acceptable level. 🙂

The main reason for decreasing margin as u know is increasing A & P. High margin is good but is it sustainable if not enough investment is make through A & P? A&P is not just current expenses but investment for the future for company like Beauty China and expenses off in the year they are spent.

If you look into their IPO prospectus, Beauty China only earn part of the value chain which leave out manufacturing, logistic and retail. The brand management margin should be the most lucrative. Don’t think the manufacturing arm increase the margin but it will increase the absolute amount of profit if nothing goes wrong. It may be part of the reason or because they want to control the quality. I don’t know.

Drastically? Maybe not but enough to alarmed me in FY2007. 1Q2008 look ok. It does not look like unable to claw back money but more like the following 2 reasons( can be more. I don’t know)
1) Push sale to make up the numbers at the end of the year.
2) Longer credit period for retailers due good relationship established over the years and longer credit period for supermart like Wal Mart, etc.

I remember reading somewhere in their past year annual report in which the management talking about opening flagship showroom somewhere in Beijing or shanghai…but i could find anywhere they talk about the flagship showroom again and instead, they go to compete with their sub-contractor. haha.

will see how their factory investment works out…

I am very interested in shipbuildings companies as yangzijiang dropped to 0.8 from 2+. Mind if you share ur resources of shipbuilding industry? I remember somewhere you write shipbuilding has peaked last year. where do you get those industry analysis and reports?

I love the idea of flagship showroom(how they run it is another thing). It is about brand building and how I wish they do it earlier.

I have only look at offshore shipping which is the playground of offshore oil so China shipyards like yangzijang, cosco and JES(?) are out since they are not in that niche. Generally I don’t like shipbuilding and owning. While China is the future of shipbuilding, the whole industry suck as the capital seldom get out of the steel and vessel. The current bloom for all shipping type is out of the norm(world) and one can easily and safely say once it is over, we may not going to see it for many, many years.. Just take note of their margins, cashflow and ROE for comparison with other industries and to look back when the bloom is over.

I usually go to marcon International for news on offshore but recently their reading materials keep decreasing.

As for predicting the peak on offshore shipping? I think recent news say it is continuing.. That show my predicting power.:)